BLRC has a limited mandate and so its recommendations have to dovetail into a larger reform to be effective. Its not going to be easy
Finance Minister Arun Jaitley has promised the introduction of comprehensive bankruptcy code of global standards to induce legal certainty and speed in recovery, in his Budget of FY-2016. This means the interim report of Bankruptcy Law Reform Committee (BLRC) released in February 2015 must lead us to the desired bankruptcy code. Has the interim report diagnosed the legal infirmities, and proposed effective remedies to design the promised bankruptcy code?
The BLRC has limited itself only to proposing amendments in the sections in Companies Act, 2013 (CA-2013) relating to revival or liquidation of borrowing entities. National Company Law Tribunal (NCLT) will handle execution of these sections. With this, the Board for Industrial and Financial Reconstruction (BIFR), which has failed in rescue / liquidation mandate under CA-1956, for three decades will be wound up. Major recommendations of the BLRC include:
• “Insolvent / distressed but viable companies” should be referred to court/ tribunal driven “out-of-court” collective rescue process. The collective rescue process is considered as a panacea for separate debt enforcement actions of the lenders who are “over-collaterised”.
• Section 253 of the CA-2013 should be amended to facilitate initiation of rescue proceedings by any creditor whose debt instalment of at least Rs1 lakh is unpaid for 30 days, as against the proposed provision of 50% creditors by value referring to NCLT for initiation of rescue proceedings. Unsecured creditors have also been proposed to be given the same right.
• Redrafting of sections 253 and 258 should be done to ensure that the viability of a company is taken into account while determining its sickness and enabling the creditors to have a say in the decision. Towards this end, the committee of creditors will be required to submit report on company’s viability to the NCLT which would examine the company’s sickness at the time of examining viability. The decision on the rescue or winding up has been proposed to be made within two months of filing of the initial application instead of five months prescribed now, and 75% of the creditors must support rescue or liquidation of the company.
• Viability should be the most important consideration for the company to be rescued. Unviable insolvent companies cannot be allowed to function for extraneous considerations. Hence the liquidation should be done fast.
• To facilitate sale of business on a going concern basis, moratorium on the enforcement proceedings under Recover of debt due to Banks and Financial Institutions (RDDBFI) and The Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI) Act for a maximum non-extendable period of 30 days.
• Debt restructuring under scheme of arrangement has been described as “effective tool for debt restructuring”. Under such arrangement, the sale of the business prior to initiation of insolvency proceedings has been suggested under the supervision of NCLT.
• For resolving financial distress of Micro, Small and Medium Enterprises (MSMEs), a statutory administrative mechanism for rehabilitation of distressed but viable MSMEs have been proposed. This is considered necessary given the crippling costs of handling courts/ tribunals. Such administrative mechanism is expected to be useful even after the Insolvency Code is operationalised.
• Cognizance has been taken of the delay tactics adopted by the defaulters and leniency shown to the defaulters by the courts. In particular, it has been recognized that BIFR failed to resolve the cases also due to reversal of BIFR orders on winding up by high courts. In order to eradicate delays that rendered BIFR ineffective, it has been suggested that NCLT should ensure pass winding up orders only in exceptional circumstances. Besides, it has been suggested that (i) the relationship between the NCLT and the superior courts should be closely monitored and subject to ongoing review, and (ii) the judiciary should be sensitised about (a) the economic costs of delays in liquidation and rescue proceedings, (b) benefits of insulating the NCLT and the NCLAT from a review on merits.
The defaulters have always used BIFR as a strategy to delay the legal process ad-infinitum. The lenders, therefore, rely on SARFAESI Act which has precedence over Sick Industrial Companies (Special Provisions) Act, 1985 (SICA) or BIFR. Notwithstanding BLRC’s description of SARFAESI as “fairly successful”, the act has also not cured the malady going by huge backlog of SARFAESI section 17 applications of the defaulters in tardy DRTs.
Banks adopt liquidation through SARFAESI Act as a last resort when the restructuring fails. Hence once the borrower’s business is determined as unviable, and the account turns NPA, the banks would prefer SARFAESI Act except when NCLT is known to deliver speedy adjudication and liquidation. The banks would also prefer a speedy NCLT to CDR owing to effective legal sanctity of NCLT. Evidently the borrowers would rush to NCLT to frustrate SARFAESI action by the lenders. CA-2013 allows SARFAESI to have precedence over NCLT with support of 75% or more of the creditors by value.
Debt recovery legislations have failed so far more due to judicial inefficiency than legislative inadequacies. The interim report has proposed remedies to fix judicial inadequacies that had rendered SICA / BIFR ineffective, through amendments in CA-2013. It has also made broad suggestions for efficient organization and management of the NCLT. It has not included other legislations which impede recovery by the creditors. The BLRC has suggested adoption of section 15 of SARFAESI Act for change of management, but has failed to suggest any provision for sacrifice by defaulting promoters. What is the scene elsewhere?
In the US, the distressed firms that are subjected to out of court or Chapter 11 restructuring see turnover or replacement of over 90% chief executives (CEOs) and 70% of other key managers over two to four years period. Such personnel are not employed by public traded firms for three subsequent years. The key feature of the debt restructuring in the US is a substantial change in the ownership of the borrowing firm. Study shows that as high as 80% of the equity capital of the restructured firm is distributed to the creditors, with the banks receiving upto 36% of such firms’ equity. Similar results of bankruptcy are seen in many other countries. To induce discipline, the Indian bankruptcy code will have to ensure commensurate sacrifice by the sponsors as well.
Determination of potential viability entails expertise in corporate finance, not law. Hence BRLC’s suggestion that the viability should be examined by a committee of creditors is the right approach. The liquidation can be piecemeal or wholesale, and the assets can be put to better economic use if the liquidation process is speedy. The report supports speedy liquidation of unviable units which again is the right approach.
Enabling and rejuvenation of the NCLT is welcome, but can it improve the banks’ recovery process? A few examples of the dilatory tactics adopted by defaulters will highlight the challenges.
• ABC Ltd defaulted to a financial institution (FI) in 1996. The FI moved Delhi Debts Recovery Tribunal (DRT) and received receive recovery certificate (RC) in late 1998. Undeterred, a relative of the defaulters moved the High Court seeking permanent and mandatory injunction under the plea that he had claim on one third share in the mortgaged property pursuant to family settlement, and hence the auction of the assets by the FI should be stayed. In January 2000, the Court granted stay and transferred the case to Tis Hazari Court due to pecuniary jurisdiction. The stay continues for the last 15 years, with application of SARFAESI Act rendered ineffective.
• XYZ Ltd defaulted to a bank in 2004. The bank took action under SAEFAESI Act and despite delaying tactics of the promoters, got the defaulters’ plea under section 17 of SARFAESI Act dismissed in 2005. The defaulters managed to link the matter to resolution of company petition of 1981, and got the stay from high court. The company petition which is unresolved for 34 years is standstill and the bank’s efforts to liquidate the assets under SARFAESI have been thwarted with no end in sight.
• PQR Pvt Ltd defaulted to a FI in 2007. The FI adopted SARFAESI route. The promoters claimed encumbrance of the mortgaged property on the basis of tenancy, and got stay from city Civil Court against SARFAESI action. The FI filed writ petition in high court. The matter continues to drag.
There are countless such examples where the defaulting promoters indulge in collusive and third party suits under the provisions of Specific Performance Act, 1965 coupled with Civil Procedure Code (CPC), in an attempt to falsify the security and delay the recovery process ad-infinitum, only to exploit and strip the assets with impunity. The lower courts exacerbate matters often by exceeding the jurisdiction. While the bankruptcy code is in the offing, it is advisable that provisions for heavy costs are introduced on losing defaulters and for seeking adjournments so that such frivolous suits are eradicated.
For the bankruptcy code to become effective there will have to be unification of NCLT’s mandate under CA-2013, with (i) suits for tenancy, partitions, temporary and permanent injunctions, and (ii) RDDBFI Act so that liquidation process is unified. Besides, the NCLT will have to be made equivalent to high court. The aggrieved parties can approach Appellate Tribunal of NCLT, and thereafter to the Supreme Court for final remedy. The government will have to set up adequate benches of NCLT and NCLAT across the country to ensure that the disposal is speedy, and the defaulters desist from treating NCLT as an instrument of ceaseless hearings. The Supreme Court will also have to add adequate benches to ensure speedy justice.
NCLT though proposed 12 years back has not been adopted so far. Hence, if bankruptcy code has to be evolved through unification of relevant laws, the government has to move very fast.
If a unified bankruptcy code executed through NCLT or any other body delivers speedy adjudication and liquidation, SARFAESI will become irrelevant. Till this marvel is achieved, the government will have to continue with SARFAESI and even strengthening by requisite amendments and adequately staffed DRT benches.
(Rajendra M Ganatra is Managing Director & CEO of India SME Asset Reconstruction Co Ltd-ISARC. He had over 25 years of experience in project finance, asset reconstruction and financial restructuring. The views expressed in above article are personal.)